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Credit Rating Agencies Like S&P Not Great At Predicting Sovereign Defaults

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Markets plunged this week after Standard & Poor’s downgraded the United States’ sovereign credit rating. But if history is any guide, the pronouncements of major credit rating agencies generally turn out to be less than accurate.

An analysis conducted by the Wall Street Journal finds that the ratings assigned by agencies like Standard & Poor’s and Moody’s have historically borne little relation to whether or not a government will default on its debt.

The WSJ found that since 1975, Standard & Poor’s has evaluated 15 governments that went on to default a year later. Of these 15, S&P assigned 12 a rating of B or higher. Moody’s has a similarly poor track record, having deemed 11 out of 13 countries a B or higher within a year of their default.

The findings are another blow to the credibility of the major rating agencies, which have received heavy criticism for their role in the 2008 financial crisis. Firms like Fitch Ratings, Moody’s and Standard & Poor’s assigned top ratings to mortgage-linked securities that turned out to be toxic assets. In a report issued this January, the Financial Crisis Inquiry Commission called these agencies “key enablers of the financial meltdown” and concluded that the crisis “could not have happened without the rating agencies.”

A separate report, released in April by the Senate Permanent Subcommittee on Investigations, said that when S&P and Moody’s began downgrading mortgage-backed securities and collaterized debt obligations en masse in 2007, those reassessments served as “the immediate trigger for the financial crisis.”

Last Friday, Standard & Poor’s issued a downgrade of the United States’ debt rating, lowering it from AAA to AA+ and touching off a volatile week in the stock market.

In response, administration officials repeatedly emphasized that rating agencies are not infallible. In a blog post on the U.S. Treasury's website, John Bellows, acting assistant secretary for economic policy, called into question S&P's "credibility and integrity."

In remarks Monday, President Obama told the nation that “no matter what some agency may say, we’ve always been and always will be a AAA country."

Rating agencies often misjudge how close a country may be to default because they tend to overlook political conditions, focusing instead on financial indicators that change gradually over time, said the WSJ. Many investors see bond markets as a more reliable barometer of a government’s default risk.

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